Risky business: threats and opportunities

Shale news
Shale news
Opinion by Jamie Dixon

Forecasting the future is risky – businesses that fail to look forward and plan ahead will almost certainly be left behind in an increasingly competitive, globalised world.

Ernst & Young’s latest Business Pulse report examines current thinking, insights and the expectations of oil and gas industry executives and EY specialists to compile the top 10 risks and opportunities facing the sector this year.

A new entrant to the top 10 risks

The research shows that, health, safety and the environment (HSE), regulatory compliance, price volatility and the increasing challenges associated with accessing reserves and capital markets take the top spots in this year’s table of risks facing the sector. A new entrant to the top 10 risks this year is IT security, specifically the threat to companies’ operations by cyber attacks or cyber theft of their intellectual property.

New opportunities

As regards opportunities for the sector, rising emerging market demand tops this year’s table. With the continued growth of the world’s emerging economies, energy demand will rapidly increase and the opportunity for oil and gas companies to take advantage of this is immense.

The opportunities list also saw many fresh entrants this year, including new infrastructure to gain access to or connect resources and markets, safety and risk management used as a partnership enabler, and new or expanded markets for natural gas.

The sector’s most significant risks and opportunities were discussed under three key themes in the report: interaction with governments and regulatory bodies; counterparty risk management and core business focus; and the pace of technological advances.

Interaction with governments and regulatory bodies

As supply chains across the world become increasingly interconnected, managing these against a backdrop of multiple governments with ever-changing policies and regulations is a huge challenge. This combined with companies moving quickly into new geographical and technical areas compounds the risks facing the industry, governments and regulators.

Key regulatory issues include risk of a health, safety or environmental incident and ensuring regulatory compliance, access to reserves or markets, uncertain energy policy and worsening fiscal terms.

Companies that can overcome these risks, are fully aware of their capabilities and are trusted by all stakeholders, will have the most success in their interactions with governments and regulatory bodies. The prize will be two-fold – access to rapidly growing markets across the world and the fuel with which to feed their increasing energy demands.

Another key opportunity that effective interaction with governments and regulatory bodies can provide is access to frontier acreage – Arctic, ultra-deepwater fields and in regions rich in shale oil and gas. Respondents noted that many companies seeking to access frontier acreage will adopt a first-mover strategy, building long-term partnerships with relevant governments and regulators.

Counterparty risk management and core business focus

The inherently complex and capital intensive nature of the industry means that joint ventures are commonplace, as are multiple, complex supplier relationships. The key risks that this counterparty dynamic creates are: managing long-term investments with the potential for extreme price volatility; cost escalation and inflation on more technically challenging projects; the human capital deficit facing the industry with regards to highly skilled labour; and the increasing scale and complexity of future developments.

Companies that effectively manage partnerships around a joint agenda of trust and responsibility are best-placed to succeed in an environment facing such risks. Many companies are now considering the terms of their contractual arrangements with counterparties, including indemnities, protection against pre-existing obligations, limiting liabilities or – from the operator side – ensuring that partners share risk proportionately.

At the same time, across both upstream and downstream operations, the landscape is becoming more competitive and complex. This necessitates greater focus on the core competencies of a business. Whether specialised talent is acquired through talent management programmes or a more streamlined organisational structure, firms must adapt to this new industry dynamic.

Pace of technological change

There are significant opportunities for oil and gas companies looking to utilise new technology to identify and commercialise resources, access new markets, serve existing markets more effectively and to lower costs. There are, however, major risks associated with such technological development.

Companies that are seen as strong innovators are trusted, attractive partners, although they must balance cost-efficiency with their continuous search for the next big technological breakthrough. Given that oil and gas companies are often investing in mega projects that have a business case and asset lifetime of 20-30 years, the risk of asset stranding due to a technological breakthrough is one that companies need to consider.

While the innovation has delivered immense benefit to both the industry and the consumer through infrastructure that connects resources and markets, the risks associated with having a physical network controlled digitally are significant. Oil and gas facilities are crucial to a country’s national infrastructure and are likely to be among the primary targets for cyber attacks.

Companies must keep one step ahead of individuals or organisations that may attempt to compromise IT infrastructure. Consequently, IT security has moved from the periphery of risk management to the core of corporate operations.

Major technological advances across the industry have transformed its dynamics, opening up possibilities and vulnerabilities for all its players. Within such an environment, the risk of either being left behind or being caught unaware by an external threat is ever-present. However, those that succeed in the future will continually monitor and adapt to this changing environment with prudent, targeted investments in technologies likely to yield revenues in the medium to long term.

Emerging challenges

These are often thought of as predictable, and therefore manageable, but at some point present a degree of volatility and unpredictability that may derail strategic and commercial decision making.

Risks associated with access to finance and capital market constraints are increasing, and creative financing techniques and new sources of finance will be needed to facilitate the allocation of risks.

The rapid oil price rises that have underpinned returns for the last decade have stalled and are expected by many to reverse. With oil and gas capital requirements forecast at around $700billion a year for the next 15 years and the continued evidence of cost pressures throughout the value chain, capital challenges seem likely to increase in future years.

Jamie Dixon is director, Ernst & Young Aberdeen Assurance Team